Real Estate Appreciation Rate Using Percent Change from Normal Distribution Curve

Good morning and good news! I woke up this morning and started working on adding in some additional ways to randomize variables in the Nomad Calculator 3.

Earlier this month, I added the ability to set a House Variable to a random number between a high and low. With the way I previously coded it, for example, I could say the house price appreciation is somewhere between -5% per year and 5% per year (calculated monthly). This meant that each month you decided to run this Rule, the real estate portfolio modeling software, would pick a random number between -5% and 5% and set the appreciation rate equal to that.

As some of you might imagine, that meant that the results were erratic. You could have a month where your property went up in value at a rate of -5% per year (since we calculate it monthly though… it means it went up 1/12 of that for that month) but the very next month we could, if the random number gods made it so, have it go up 5%. For modeling reality, I found this highly unlikely when talking about appreciation. For things like modeling maintenance costs on a property, a truly random number between a range might be an acceptable way to model it. Of course, you can choose the range of random numbers, but still, it was completely random.

Back to appreciation rate though… when we are modeling appreciation rates, I think appreciate rates tend to trend. For example, if a property has been going up at about 3% per year, it will tend to continue to go up about 3% per year the next month. Maybe it is going up 2.9% or maybe 3.1% but it is not likely to be -5% the next month. To model this, I decided to add an additional way to model these which will be especially helpful when we do Monte Carlo modeling of real estate investing portfolios.

Now, with the new code, I pick a percentage change for appreciation rate based on a normal distribution curve. So, I might say the appreciation rate can change anywhere from -25% to 25% in any given month with the average being that it does not change at all. So, if it was at 4% and it changed -25%, that means the next month it could be as low as 3%. But, that is not super likely. It could also go up 25% so that the yearly appreciation rate was 5%. Again, that’s not super likely either. It is most likely to remain at 4% (a change of 0%). It is also relatively likely it will drop to something like 3.9% or go up to 4.1%.

I ran it on a Scenario I had been playing around with for modeling Nomad and here’s what the appreciation rates for a number of houses ended up being.

As you may be able to see in the chart above, this shows appreciation rates that trend. Again, this is because we are adjusting the appreciation rate a percentage of what it was the previous month based on a normal distribution curve.

Appreciation FAQs

What is appreciation?

Appreciation is the tendency for property value to go up over time.

What is a reasonable appreciation rate when modeling Nomad?

According to Zillow research the historic average appreciation rate is approximately 3% nationwide. When modeling Nomad generically… not for a specific area… I recommend using this 3% appreciation rate. There probably are other markets where I’d recommend lower the estimated appreciation rate to be less than 3%.

To be conservative, even in markets where I’d expect appreciation to be higher than 3% per year (like the Northern Colorado market), I would still NOT recommend using higher than 3%.

Is appreciation just inflation?

I like to think of it that way. The cost of the materials and labor to build a home tends to increase with inflation. And if the difference between resale homes and new construction homes gets too far apart people will tend to seek out value and buy the lesser expensive ones. So, the prices of new construction and resale homes tends to remain pretty close.

If appreciation is just inflation, aren’t we just keeping up with inflation by doing the Nomad model?

Great question. The answer is no. If you are buying a $300,000 home and that home is just keeping up with inflation by increasing at a rate of… let’s say… 3% per year, then the property value is going up by about $9,000 in the first year.

If you had bought the property for cash with $300,000 down and you just made $9,000 you could argue that you’re investment of $300,000 was just keeping pace with inflation. But with Nomad, we’re often buying a $300,000 home and putting 5% down… or about $15,000. In other words, we’re controlling a $300,000 asset for $15,000 and that $300,000 asset just went up in value by $9,000. So, we really just “made” a $9,000 return on a $15,000 investment.

Even if the property value did not increase and we were just paying off the loan on the property. The returns from just paying off the debt on the property tends to be compelling by itself to encourage people to do Nomad.

Does Nomad work with no home appreciation?

Yes, it is still worth doing Nomad if you have no home appreciation.

Using the same example from the Catch Up Nomad Example with a $286K Property, with all the same assumptions including a 3% home appreciation rate, you’d accumulate $14M compared to just over $5M investing in stocks. Here’s the summary image of that.

286k-catch-up-nomad-stock-market-versus-nomad-example

If we take all the same assumptions but change the home appreciation rate from 3% per year to 0% per year, here’s what that ends up looking like.

286k-catch-up-nomad-stock-market-versus-nomad-example-no-appreciation

As you can see, you still end up with almost $10M versus $4.4M if you had invested the same amount in the stock market at 10%. Some astute people may ask why did you earn less with the stock market if you only changed the home appreciation rate. Another great question… it is because we’d invest less overall in down payments and negative cash flow since the property values are not going up.

Here’s a final… logical extension of that question… what happens if property values do not go up and neither does rent. In other words… no home appreciation and no rent appreciation. In still other words… property value nor rent goes up at all over 40 years. What does that look like? Using the same assumptions as above with just those two changes, here you go:

286k-catch-up-nomad-stock-market-versus-nomad-example-no-home-or-rent-appreciation

What happened! It is better to invest in stocks. Well… what happens is that the slight negative cash flow we had when we originally bought the properties never goes away. In our initial model, we see our expenses like the mortgage payment remain fixed and rents increase even slightly giving us more positive cash flow over time. If we have negative cash flow for long periods of time, we’re investing a lot more into the stock market (since we invest all down payments and negative cash flow)

If we had positive cash flow, we’d expect Nomad to continue to outperform the stock market.

Does appreciation usually exceed inflation?

No. There are some great studies done by economists Case and Schiller than suggest that real estate has largely kept pace with inflation over a very long period of time. In the short term, real estate prices can outpace inflation or under- perform compared to inflation.

Does rent appreciation usually match house appreciation?

For the most part, rent inflation tends to keep pace with house inflation. When I originally modeled Nomad I used to model it with rent increasing less than the home values were increasing. I felt that was more conservative. Then I saw the following chart from the National Association of Realtor’s chief economist showing the rent versus home price chart.

home-price-versus-rent

Based on this chart, it seems to be that while the rent or price can outperform one or the other, the overall trend is that they tend to perform about the same over a long period of time.

Will my expenses increase faster than appreciation?

One of the interesting things about expenses on rental properties is that some of them are fixed and don’t change (like the monthly mortgage payment) and some increase with inflation like taxes, insurance, maintenance, etc.

In the chart below you can see that the mortgage payment (which does not increase) is a major percentage of your overall expenses. Remember, this payment is fixed and does not increase over time. All the other ones can and probably will.

rental-property-expenses

Because the largest part of your expenses is fixed the chance of your overall expenses increasing faster than appreciation is not likely.

Is there ever negative appreciation?

Yes. There have definitely been markets and periods of time in the past where property values have declined. It is a real possibility. However, over a very long period of time, real estate values have tended to go up.

Do property value ever go down?

Yes, sometimes property values go down.

Does appreciation vary?

Yes… even though we model 3% per year for many of our presentations on Nomad, appreciation can vary over time and from property to property. We use 3% as a long term average, but we might see -3% one year and plus 6% another year.

Is appreciation the same for all houses in a city?

No. Appreciation can vary from house to house so that a house on one side of the street goes up in value more than a house on the other side of the street.

Is appreciation fixed each year?

No… appreciation is not fixed for the year. It can vary. For example, you could have really high appreciation for the first half of the year and see property values decline over the next half of the year.

Does appreciation vary from house to house?

Yes. Appreciation of certain houses can be more than others. Over time people tend to value quality, so quality properties in quality locations tend to appreciate slightly better.

Does appreciation vary from neighborhood to neighborhood?

Yes. Appreciation can vary from one neighborhood to another in the same zip code and city.

Does appreciation vary by price range?

Yes. Appreciation can be better in different price ranges as supply and demand for properties in those price ranges improve and decline.

What can I do to improve appreciation on the houses I buy?

While it is hard to control big picture economic factors around your property like the financial well-being of your city as a whole, you can do some things to improve the odds that your property will appreciate.

Some of this factors that affect appreciation is the condition you keep the property.

What is forced appreciation?

When we buy a property that needs to be fixed up and we do that fix up, we often call that forced appreciation because we did something to force the property to be worth more than before we did the updating or fixing up.

Can I use appreciation to determine home values?

Sort of… while you can do some rough math to see what a property might be worth based on appreciation rates, it is not the same as pulling up sales that are comparable to the property you’re considering to see what other similar properties sold for recently.

Where can I find out what the appreciation rate of my city is?

Many real estate agents will be able to provide that data for you for your city. You may also be able to search for “Appreciation Rate Fort Collins” and replace “Fort Collins” with your city.

Will appreciation help me qualify to buy the next Nomad home?

Probably not directly if you’re just holding on to the properties. However, if you’re selling properties then taking appreciation you’ve captured through a sale and using it as a down payment, it probably will help you qualify for your next home.

Can I use the appreciation to buy more Nomad houses?

Yes. You can sell your home and use that money as down payment to buy more Nomad homes. Or, in some cases, and it is not something we typically recommend, you could refinance and pull cash out of your homes to use that for a down payment.

Can I use appreciation for my down payment on my next Nomad house?

Yes, you could do that in one of two ways. First you could sell your property and use the proceeds (which would include any appreciation) and use that as your down payment. Or, secondly, you could refinance your property and pull cash out and use that cash out as a down payment for your next Nomad property.

What happens to appreciation as interest rates go up?

As interest rates get higher, it is harder for people to afford more expensive homes, so it tends to suppress prices.

What happens to appreciation as interest rates go down?

As interest rates go down, monthly payments required to buy homes becomes easier which tends to raise home prices.

Does it cost more to insure a home as it appreciates?

Yes. As your property value increases you’ll want to make sure you have adequate insurance coverage in case of a claim on your property. So, you’ll end up increasing the amount of coverage on your property over time and therefore increase your cost of insurance.

Do nicer homes appreciate faster or slower?

Nicer homes tend to appreciate faster than homes that aren’t as nice. I should point out that this is relative to the other homes in the same price range.